Question

Kim Mitchell, the new credit manager of the Vinson Corporation, was alarmed to find that Vinson sells on credit terms of net 90 days while industry-wide credit terms have recently been lowered to net 30 days. On annual credit sales of $2.24 million, Vinson currently averages 95 days of sales in accounts receivable. Mitchell estimates that tightening the credit terms to 30 days would reduce annual sales to $2,115,000, but accounts receivable would drop to 35 days of sales and the savings on investment in them should more than overcome any loss in profit. Assume that Vinson’s variable cost ratio is 85%, taxes are 40%, and the interest rate on funds invested in receivables is 25%.

The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions above.

Assuming a 365-day year, calculate the net income under the current policy and the new policy. Do not round intermediate calculations. Round your answers to the nearest dollar.

Current policy: $  

New policy: $  

Should the change in credit terms be made?

Answer 1

Yes Credit term should be change because in new credit term more profit is than current policy

	Current Policy	New Policy
Average Credit Term	95 Days	35 Days
Sales	2,240,000.00	2,115,000.00
Less: Variable Cost @85%	(1,904,000.00)	(1,797,750.00)
Less: Cost of Finance	(123,890.41)	(43,096.75)
Profit Before Tax	212,109.59	274,153.25
Less: Tax @40%	(84,843.84)	(109,661.30)
Profit After Tax	127,266	164,492

Cost of finance is the cost of capital which remains blocked in debtor cost therefore finance cost is calculated on Variable cost (some also calculate on sales but that is not a good practice)

I hope this clear your doubt.

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